5 Reasons to Buy the Dip In Netflix Stock

NFLX stock tanked hard on bad Q2 numbers, but this selloff is a gross overreaction

Don't Miss the Chance to Get in on Netflix Stock Ahead of Earnings

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Shares of Netflix (NASDAQ:NFLX) dropped more than 10% on Thursday — the biggest single-day drop the stock has had in a year — after the streaming giant whiffed on the only thing that mattered in its second-quarter earnings report: subscriber numbers.

When it comes to NFLX stock, it’s all about the subscriber numbers. The more subs the platform adds, the more revenues the company generates, the more operating leverage the business gets, the higher margins go, and the more profits ramp up. It all starts with sub growth. Consequently, as Netflix’s pace of subscriber growth has accelerated over the past several years, the NFLX stock price has taken off, from under $100 to $300-plus.

But, in the second quarter of 2019, the pace of subscriber growth slowed dramatically. Throughout the past two years, Netflix has added, on average, roughly 6.5 million new global subs every. This quarter, they were supposed to add around 5 million subs. Instead, the streaming giant onboarded just 2.7 million new global subs — the lowest sub growth in three years — while subs in the U.S. actually dropped sequentially for the first time in recent memory.

The huge subscriber whiff freaked investors out, and in response, NFLX stock tanked.

But I’m not as freaked out as the market. In the big picture, Netflix remains the leader in a secular growth market, with high visibility to robust revenue and profit growth over the next several years. This bad quarterly print is just a hiccup in that long-term growth narrative.

That’s why I’m buying the dip in NFLX stock. Specifically, there are actually five reasons why I’m buying the dip in Netflix stock. These reasons are:

The Global Streaming TV Narrative Remains Robust

Nothing about Netflix’s bad second quarter says anything about the global streaming TV growth narrative. Instead, the fundamentals underlying the global streaming TV market remain very healthy, and still imply that this is and will remain one of the biggest growth markets in the world.

The fundamentals here are straightforward. According to Internet World Stats, there are about 4.4 billion internet users in the world (~57% of global population). Internet penetration rates in developed economies like the U.S. and Canada are north of 80%. Thus, as developing economies urbanize and digitize, the global internet penetration will only go up over time. It is not unlikely that this number approaches and eclipses 5.5 billion by 2025.

Assuming a global average household size of 3.5, then there are about 1.3 billion internet households in the world. As the global internet penetration rate goes up, so, too, will this number. I think it is reasonable to project roughly 1.6 billion internet households by 2025.

Of the 1.3 billion internet households today, 300 million of them are streaming TV households (about 23%). The streaming TV penetration rate will similarly rise over time as internet households continue to shift from linear to internet TV given convenience and price advantages. This number could easily expand to 650 million or more households by 2025.

Broadly, within the next half decade, Netflix’s addressable market should more than double, implying that there is a lot growth potential left in this company.

This Was One Bad Quarter, During A Typically Weak Time Of Year

One quarter — good or bad — does not define a trend. A trend is defined by a string of consecutive good or bad quarters. As such, when looking at Netflix’s big second quarter whiff, it is important to contextualize the miss.

First, it is important to understand that Netflix missing on sub numbers isn’t unusual. Over the past several years, it has happened once every three to four quarters. From early 2018 to early 2019, Netflix had rattled off a string of three consecutive sub beat quarters. Thus, history says that this second-quarter sub miss is par for the course in the long term trend.

Second, it is equally important to understand that the second quarter is never all that important for Netflix. As stated earlier, Netflix has added roughly 6.5 million new global subs per quarter since the start of 2017. Breaking that down, the average adds in non-Q2 quarters is 7.1 million, while the average adds in Q2 quarters is 5.1 million. Further, Q2 represented just 12%, 21%, and 19% of global subs adds in 2016, 2017 and 2018, respectively.

To be sure, the scope of the miss (5 million expected versus 2.7 million actual) is the widest miss ever. But, that’s mostly because Netflix just gave a bad guide a few months back. Ignoring that, then, this is just one not-that-unusual bad quarter that was expected in the long term trend, and which happened during a not-that-important time of year for Netflix.

There’s Reason to Believe Next Quarter Will Be Much Better

There are many reasons to believe that Netflix’s numbers will be both much better next quarter, and more in-line with the long term growth trend.

First, ever since the streaming era kick-started a few years back, Netflix management has never missed on its own sub guidance in back-to-back quarters — after they miss on sub guidance in one quarter, they usually set the hurdle for the next quarter at a level which they can easily clear. Following this big Q2 miss, they are guiding for a very strong 7 million net adds next quarter. Given management’s track record of never missing twice in a row, I’d say that July sub trends have been very strong, and that the 7 million net add figure for Q3 is very doable.

Second, summer is always a good quarter for Netflix. From 2016 to 2018, Netflix missed on Q2 sub guidance twice, but never missed on Q3 sub guidance.

Third, the summer content line-up is very good. Things got started with a bang when Stranger Things 3 broke viewership records. Next up, a new season of fan favorite Orange Is The New Black is due at the end of July, as is the Chris Evans-led and star-studded film The Red Sea Diving Resort. A second season of Mindhunter is also due in August.

Fourth, apparently smart TVs and streaming devices were big sellers during Prime day, implying that more consumers could be engaged in the streaming TV world this summer than ever before, and that should show up favorably in Netflix’s next quarterly print.

Overall, then, all trends indicate that Netflix’s third-quarter numbers will be a lot better than their second-quarter numbers.

Secular Advantages Will Keep Netflix Atop The Streaming TV Market

Zooming out, NFLX stock  is still supported by two secular advantages which should help keep this platform atop the rapidly growing streaming TV market for the foreseeable future.

First, Netflix is bigger than everyone else by a mile. This size does two things. One, it makes Netflix the standard for streaming TV, so chances are high that if you pivot into streaming, your first purchase is going to be a Netflix subscription. Two, it gives Netflix huge reach, so they can justify spending tons of original content because that content has the opportunity to be viewed across 150 million-plus households. No other streaming platform has this luxury.

Second, because Netflix is bigger than everyone else by a mile, they also have more data than everyone else, and it’s not close. Netflix has regular viewing data on over 150 million households around the world, giving them unprecedented insights into what consumers like to watch. Those insights form the basis for data-driven content production, which Netflix has leveraged and continues to leverage to produce some of the best content in the world. No one else has that many insights, and Netflix’s sub base is only growing, so Netflix will only get smarter and smarter over time with content production.

All in all, because of these two secular advantages and the fact the streaming TV market isn’t a zero-sum game (households can and do subscribe to multiple services), concerns about forthcoming competition are overstated, and Netflix projects to remain the leader in this market for a lot longer.

Netflix Stock Now Trades At An Attractive Discount

The biggest reason to buy the dip in NFLX stock is that the stock now trades at an attractive discount to its fair value.

Exiting 2018, assuming roughly 300 million global streaming TV households, Netflix controlled about half of that market. As stated earlier, the number of global streaming TV households could grow to about 650 million by 2025. Netflix will likely control anywhere between 40% and 50% share. That implies around 300 million subs by 2025.

Alongside that big sub growth, average prices and gross margins should trend higher, while the opex rate should fall with scale. Putting all that together, Netflix should be able to net about $25 in EPS by 2025. Based on a big growth multiple of 25-times forward earnings, that implies a fiscal 2024 price target for NFLX stock of $625. Discounted back by 10% per year, that yields a 2019 price target of roughly $390.

Thus, at $320, NFLX stock seems attractively discounted.

As of this writing, Luke Lango was long NFLX. 


Article printed from InvestorPlace Media, https://investorplace.com/2019/07/5-reasons-to-buy-nflx-stock-the-dip-in-netflix-stock/.

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